15 October 2008 Internal T.I. 2008-0269721I7 - SR&ED Expenditures and Joint Venture

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: 1. Would the joint venture (JV) be considered to be operating a business and would each member of the JV be considered to be in the same business even if they have designated one of the participants, the Operator, to run this business? 2. Is there an implied agency relationship between Corporation A (the Operator) and the other JV members by reason of the fact that the JV agreement states that the JV operations will be run by one JV participant - the Operator - with the other JV members providing financial contributions? 3. If there is no implied agency relationship, has Corporation A performed SR&ED work for itself and on behalf of the other JV members by reason of having performed the SR&ED work and because of the fact that the other JV members provided only financial contributions to the JV such that only Corporation A would be entitled to claim ITC? 4. Can each JV member claim their proportionate share of SR&ED salary or wages for employees of the Operator or must the JV member claim these expenditures under subclause 37(8)(a)(ii)(B)(II) or paragraph 2900(2)(c)? 5. Can an amount of foregone revenue of a JV member be considered that member's contribution and expenditure for SR&ED purposes? 6. Can a JV member who is not actively involved in the JV operation (e.g. Individual 2), and not operating any other business, claim SR&ED ITCs?

Position: 1. Yes. 2. Maybe. 3. Depends 4. Depends. 5. Yes. 6. Maybe.

Reasons: See reasons in the interpretation.

								October 15, 2008

	Chris Boucouvalas, CA				HEADQUARTERS
	Policy Development Division			André Gallant
	SR&ED Directorate					613-957-8961

								2008-026972

SR&ED expenditures and members in a joint venture

This is in reply to your memorandum of February 22, 2008, concerning the entitlement of members in a joint venture ("JV") to claim scientific research and experimental development ("SR&ED") expenditures and related investment tax credits ("ITC") in the hypothetical situation described below. We apologize for the delay in responding.

Our understanding of the facts is as follows:

1. JV is comprised of 4 members: two of the members are corporations, Corporation A and Corporation B, each holding XXXXXXXXXX % interests in the JV, and the other 2 members are individuals, Individual 1 and Individual 2, each holding XXXXXXXXXX % interests in the JV. All the members are dealing with each other at arm's length.

2. The following are some excerpts of the JV Agreement:

a. The Agreement states that each member of the JV agrees to jointly undertake the exploration, development and operation of the XXXXXXXXXX

b. The Agreement specifically stipulates that the arrangement between the members is not a partnership agreement but is a joint venture agreement.

c. The Agreement establishes a Management Committee that determines overall policies and objectives under the Agreement. The Management Committee resolves all the issues by vote with each member of the committee being entitled to the number of votes equal to the participating interest in the JV.

d. The JV members appoint Corporation A as the Operator of the property and the Operator's responsibilities are defined in the Agreement.

e. The Operator is subject to work plans, budgets, policies and objectives of the Management Committee.

f. Each JV member agrees to participate in the work program, and agrees to contribute funds equal to its participating interest in the JV, to fund the operations.

g. The Agreement confirms that all the information obtained from the work carried out within the JV shall be the exclusive property of the parties to the JV.

h. The Agreement provides that all costs incurred shall be for the account of the members of the JV in proportion to their respective participating interests, and each member of the JV on whose behalf any costs have been incurred shall be entitled to claim all tax benefits, write-offs and deductions with respect to these costs.

3. The JV has operated for several years XXXXXXXXXX for a profit.

4. In the current year, the JV Operator (Corporation A) performed SR&ED work to improve the XXXXXXXXXX .

5. Corporation A, Corporation B and Individual 1 operate other businesses in the XXXXXXXXXX . Individual 2 is not operating any other businesses nor is he actively involved in the JV business.

6. Each of the four JV members has filed a tax return including Form T661 and has claimed a proportionate share of SR&ED expenditures made by the Operator based on their interest in the JV. An excerpt of their respective Form T661's is as follows:

Corporation A
Corporation B
Individual 1
Individual 2
JV Total
Salaries & wages
XXXXXXXX
XXXXXXXX
XXXXXXX
XXXXXX
XXXXXX
Materials
XXXXXXXX
XXXXXXXX
XXXXXXX
XXXXXX
XXXXXX
SR&ED Contractors
XXXXXXXX
XXXXXXXX
XXXXXXX
XXXXXX
XXXXXX
Overhead1
XXXXXXXX

XXXXXXX
XXXXXX
XXXXXX
Total
XXXXXXXX
XXXXXXXX
XXXXXXX
XXXXXX
XXXXXX

1Corporation B and Individual 1 claimed the Proxy Method.

7. The CRA's Research and Technology Advisor has conducted a thorough review of the work performed by the JV Operator and has concluded that the work meets the definition of SR&ED in subsection 248(1) of the Act.

In relation to the above hypothetical situation, you have raised a number of questions (Issues):

1. Would the above JV be considered to be operating a business and would each member of the JV be considered to be in the same business even if they have designated one of the members, the Operator, to run this business?

2. Is there an implied agency relationship between Corporation A (the Operator) and the other JV members by reason of the fact that the JV Agreement states that the JV operations will be run by one JV member - the Operator - with the other JV members providing financial contributions?

3. If there is no implied agency relationship, has Corporation A performed SR&ED work for itself and on behalf of the other JV members by reason of having performed the SR&ED work and because of the fact that the other JV members provided only financial contributions or has Corporation A performed SR&ED as part of its contribution to the JV such that only Corporation A would be entitled to claim ITC?

4. Can each JV member claim a proportionate share of SR&ED salary or wages of employees of the Operator or must each JV member claim these expenditures under subclause 37(8)(a)(ii)(B)(II), as an expenditure for SR&ED directly undertaken on that member's behalf when electing under the proxy method or as an expenditure all or substantially all attributable, or directly attributable to the prosecution of SR&ED under paragraph 2900(2)(c) when using the traditional method?

5. If the JV Operator (Corporation A) is performing SR&ED for the JV, can the other JV members still claim these SR&ED expenditures if instead of actually making financial contributions to the JV they forgo their share of the JV revenue to the Operator? (If the JV operations are sufficiently profitable, the JV members do not provide financial contributions.) In other words, would the share of JV revenue foregone by a JV member be considered an expenditure made to the Operator as contribution towards the Operator's SR&ED expenditures?

6. Can a JV member who is not actively involved in the JV operation (e.g. Individual 2), and not operating any other business, claim SR&ED ITCs?

Position of the SR&ED Directorate

It is the SR&ED Directorate's understanding that each JV member must be performing SR&ED on their own to claim SR&ED expenditures. The SR&ED claims filed by each JV member should be reviewed independently of one another's claim and the normal requirements would apply in determining whether or not

• there is eligible SR&ED work,
• the expenditures incurred should be included in the SR&ED expenditure pool, and
• the expenditures qualify to earn an ITC.

In order to be entitled to a deduction in computing income under subsection 37(1) of the Act and in computing taxes payable under subsection 127(5) of the Act for ITC earned in respect of SR&ED expenditures, each JV member (taxpayer) would have to satisfy the following requirements:

• the taxpayer must be carrying on a business;
• there was SR&ED directly undertaken by, or on behalf of, the taxpayer and the SR&ED was related to the business of the taxpayer; and
• the taxpayer incurred expenditures for SR&ED carried on in Canada.

You acknowledge the fact that just because a particular business arrangement calls itself a JV does not preclude the CRA from treating the arrangement as a partnership. As described in paragraph 2 of Interpretation Bulletin IT-90, the CRA will view provincial partnership law as persuasive in determining whether a particular arrangement constitutes a partnership. As per the answer to question 15 of the 1988 Canadian Tax Foundation Conference, the CRA's experience is that many so-called JV's are in fact partnerships. However, for discussion purposes, you asked us to assume that the arrangement described above is not a partnership at law and has been correctly identified as a JV.

Under subparagraph 37(1)(a)(i) of the Act, a taxpayer can claim SR&ED expenditures of a current nature when the SR&ED carried out is related to a business of the taxpayer. Paragraph 34, of Interpretation Bulletin IT-151R5 (Consolidated) states that for SR&ED to be related to a business carried on by a taxpayer, "it is necessary to have some interconnection or link between the SR&ED activities and the taxpayer's business. This requirement will generally be satisfied when the results of the SR&ED, if successful, have a direct and beneficial application in the business that is carried on by the taxpayer. Paragraph 37(8)(b) of the Act provides, for greater certainty, that references to SR&ED related to a business include any SR&ED that may lead to or facilitate an extension of that business."

Subsection 37(1.1) of the Act provides that a particular corporation's SR&ED that is related to a business carried on by a corporation that is related to the particular corporation (otherwise than because of a right under paragraph 251(5)(b) of the Act) is considered to be related to the business of the particular corporation. The SR&ED Directorate refers to CRA document E9821866 which seems to allude to the fact that individuals participating in a JV may not have a business, if they are investors and the JV itself does not operate a business and to CRA document 2002-0158127, which deals with joint development research projects and states: "given that each member in a joint venture carries on business separately, we are of the view that the determination of SR&ED eligibility for a joint venture remains at the member level...and all of the requirements of 37(1) have to be met."

More specifically, the following are your views with respect to each issue that you raised.

Issue 1

Your view is that the JV would be considered to be operating the XXXXXXXXXX business and that each JV member would be considered to be operating in the same business. The Federal Court ruled in Les Entreprises Blaton-Aubert Société Anonyme v. MNR (73 DTC 5009, per Noël A.C.J.) that if a JV is carrying on a business in Canada then each member of the JV is considered to be carrying on business in Canada. Each JV member is considered to be conducting its own business so that it realizes income and incurs costs to the extent of its participation in the JV.

Issue 2

Your view is that Corporation A would be acting as an agent for Corporation B, Individual 1 and Individual 2. But Corporation A would be acting on its own behalf as well. As an agent, it is your view that Corporation A would have incurred expenses on its own behalf and on behalf of the other JV members.

Issue 3

Your view is that Corporation A performed some of the work on its own behalf. If there is no agency relationship, you are unsure if it can be said that Corporation A also performed the work "on behalf of" the other JV members in accordance with subparagraph 37(1)(a)(i) of the Act so that the SR&ED expenditures made by the Operator can be claimed by the other JV members; or if the SR&ED work performed and expenditures incurred by Corporation A can be claimed only by it and constitute Corporation A's contributions to the JV, since the other JV members provided financial contributions.

Issue 4

Individuals performing the SR&ED work are employees of the Operator and not of the JV (since a JV is not a legal entity and thus cannot have its own employees). Subclause 37(8)(a)(ii)(B)(IV) of the Act allows for the inclusion in the pool of SR&ED expenditures of salary or wages of an employee who is directly engaged in SR&ED in Canada when a taxpayer elects under the proxy method, while subsection 2900(2)(b) of the Regulations, which applies for the purpose of subclause 37(8)(a)(ii)(A)(II) of the Act, allows for salary or wages of an employee that directly undertakes, supervises or supports the prosecution of SR&ED to be included in the pool of SR&ED expenditures under the traditional method.

Your view is that if the Operator is acting as agent for the other JV members, then these other JV members should be able to claim their proportionate share of SR&ED salary and wages based on their interests in the JV.

However, if Corporation A is not acting as an agent for the other JV members, then the work and related expenditures can be seen to be that of Corporation A's contribution to the JV. In the absence of an agency relationship, each JV member could only claim expenditures incurred by it for SR&ED for the JV business. If Corporation A would not be performing work or incurring expenditures on behalf of the other JV members, then the other JV members cannot rely on subparagraph 37(1)(a)(i) and 37(8)(a)(ii)(B)(II) of the Act to claim as a deduction a share of the SR&ED expenditures made by Corporation A. Therefore, Corporation A would be entitled to claim all of the salary or wages it incurred with respect to the SR&ED.

Issue 5

CRA document 2005-0115041I7 states that a corporation involved in a JV would include its share of the salaries and wages of the JV employees that are directly paid by the corporation for the purpose of the calculation of "income earned in the year in a province" under subparagraph 402(3)(a)(ii) of the Regulations.

Accordingly, with reference to the situation described above, your view is that if there is an agency relationship, then each JV member would be entitled to claim as an expenditure, a portion of salary and wages based on the member's interest in the JV. But if there is no agency relationship and it is determined that the Operator is performing SR&ED on contract for the other JV members, CRA document 2005-0115041I7 would suggest that Corporation A would be entitled to claim as an SR&ED expenditure the total amount of salary and wages.

Issue 6

Your view is that Individual 2 would be in the XXXXXXXXXX business by virtue of being a member of the JV. The SR&ED performed in the JV could be said to have facilitated an extension of the XXXXXXXXXX business. Individual 2 would be entitled to exploit the results of the SR&ED as the JV Agreement states that "all the information obtained from the work carried out within the JV shall be the exclusive property of the members to the JV". Assuming that SR&ED expenditures can be allocated to Individual 2 based on the responses to Questions 1 through 5, then Individual 2 would be entitled to earn ITC. The ITC restrictions imposed on certain members of a partnership, such as specified members under subsection 127(8) of the Act, would not be applicable to an inactive JV member since the JV described above is assumed not to be a partnership.

OUR COMMENTS

Whether a business arrangement is a partnership at law is a question of fact, as discussed in Interpretation Bulletin IT-90, What is a Partnership?

It is now becoming clearer under Canadian law that a joint venture can be something other than a partnership. Therefore, the provisions in the Act applicable to partnerships would not generally apply to joint ventures.

Not too long ago, some Canadian judges relied on US case law to conclude that a joint venture was not a partnership, while other Canadian judges relied on UK case law to arrive at an opposite conclusion: see e.g. David A. G. Birnie, "Taxation of Partnerships from A to Z - Part 1," in Report of Proceedings of the Thirty-Third Tax Conference, 1981 Conference Report (Toronto: Canadian Tax Foundation, 1982), 182-194; James G. McKee, "The distinction between joint ventures and partnerships," (1985), vol. 1, no. 17 Canadian Current Tax, at C89; and Sheldon Silver, "What is a partnership?" (Missauga: Insight Press, 1989), Article 1.

Apparently, the main reason UK judges found that a joint venture was a partnership was that the cases in issue dealt with whether a member of a joint venture was liable for actions of other members (or had a fiduciary duty toward each other). On the other hand, the US jurisprudence developed around the difficulties that arose because corporations could not become partners of a partnership and because of the dual fiduciary obligation of such partners: directors of the corporation having fiduciary obligations towards its shareholders and the corporation as a partner having fiduciary obligations towards its partners. A partnership with such corporate partners would be ultra vires in some US jurisdictions. To avoid this problem, the American judges concluded these entities were not partnership, but joint ventures. While Canadian judges had not been consistent up until the early 1980s, most of them generally thereafter followed the American approach.

More recently, the UK courts have started adopting more and more a similar approach followed by the US courts. Regarding the new UK trend, see e.g. James P. Thomas and Elizabeth J. Johnson, Understanding the Taxation of Partnerships, 5th ed. (Toronto: CCH, 2006), at pp. 5-19; and R.C. I. Anson Banks, Lindley & Banks on Partnership, 18th ed. (London: Sweet & Maxwell, 2002), at p.74.

Lindley & Banks on Partnership comments on the nature of joint ventures as follows:

"The courts tend to adopt a strangely inconsistent attitude towards joint ventures. Although partnerships and joint ventures obviously have a number of common characteristics, in some instances the two expressions appear to be used interchangeably whilst in others the joint venture is recognised as a relationship quite separate and distinct from partnership. In the current editor's view, whilst it can properly said that all partnerships involve a joint venture, the converse proposition manifestly does not hold good..." [footnotes omitted]

The CRA has recognized the trend towards the US treatment of joint ventures in its GST Application Policy P-171R:

"The common law did not always recognize the existence of joint ventures and, until recently, frequently characterized joint ventures as partnerships. Although early decisions have hampered the development of independent principles for joint ventures making it hard to distinguish between the two arrangements, there is now some evidence that Canadian courts recognize the existence of joint ventures and view joint ventures as relationships other than partnerships."

As regards the province of Quebec, P-171R provides the following comment:

"(4) The Civil Code of Lower Canada and the Civil Code of Québec do not, and never have, recognized the existence of joint ventures ("coentreprise") as such. The courts have, however, recognized the possibility of joint ventures existing in the province of Québec in very restricted circumstances."

For a recent civil law discussion on joint ventures, see e.g. Josée Laferrière, "Caractéristiques et conséquences fiscales d'une coentreprise", March 2006, Paper presented for her LL.M. (Tax) at the Université de Montréal - HEC Montréal.

As you requested, in our comments below we will assume that the business arrangement in issue in your scenario is not a partnership at law but is simply a joint venture (JV).

Issue 1

In our view, each JV member would be considered to be carrying on the XXXXXXXXXX business that is being carried on by the Operator on behalf of the other JV members: Les Entreprises Blaton-Aubert Société Anonyme v. MNR, supra. In short, the conclusion in that case was that because the joint venture business was being carried on in Canada, all members of the joint venture, including non-Canadian resident passive members, were considered to be carrying on business in Canada as well. In Les Entreprises Blaton-Aubert Société Anonyme, the taxpayer, a Belgium construction company not resident in Canada, entered into a joint venture agreement with a Canadian construction company for the purpose of constructing the Belgian pavilion for the 1967 Expo in Montreal. The taxpayer was assessed by the Minister to tax the taxpayer's share of the profit on the basis that the taxpayer was carrying on business in Canada, pursuant to subsection 2(3) of the Act.

In opposing the Minister's assessment, the taxpayer's arguments included the following:

• The taxpayer was involved in the venture at the request of the Belgian Government and was simply responsible for carrying out the contract, including the financial aspect of the project, and enforcing any legal claims of the Belgian Government. However, the taxpayer was not involved in carrying out the construction activities of the venture (although it was a construction company);
• The joint venture was not a partnership, which partnership if it had existed would have implied the carrying of a business, but was simply an arrangement providing for a division of legal responsibilities. Since the joint venture was not a partnership, the taxpayer was therefore not carrying on business in Canada;
• The taxpayer had no permanent establishment or employees in Canada and used no equipment in Canada; no contracts were entered in Canada by the taxpayer;
• The taxpayer did not participate actively in the joint venture, although it did provide the granite and the bricks for the pavilion's floor and walls, respectively;
• Although one of the two representatives of the taxpayer did travel to Canada, the travel was only for a few short visits which were considered by one witness to be formalities; and
• Although the joint venture agreement did provide for the possibility of the taxpayer appointing a supervisor in Canada and a board of management, no such appointment was made.

Despite all of these arguments by the taxpayer, the court upheld the Minister's assessment for the following reasons:

• The taxpayer was a construction company;
• The purpose of the joint venture agreement was to construct the Belgian pavilion, which was an activity in the same line of business as the taxpayer's normal and daily operations;
• If the Belgian Government was really concerned with financial risk, it could have simply required a performance bond;
• The Belgian Government also required that, in the event that the Canadian member of the joint venture could not complete the pavilion, the taxpayer take the Canadian company's place. Although there was in reality no real active role played by the taxpayer, there was a possibility that the taxpayer would have need to become very actively involved upon the replacement of the Canadian company;
• The joint venture agreement was a construction contract entered into by both members of the joint venture; and
• There was no need to determine whether the joint venture agreement was in fact a partnership agreement in this case.

The fact that the passive member of the joint venture retained the "possibility" of being engaged in the operations of the business was sufficient for the court to find that the non-resident taxpayer was carrying on business in Canada and subject to Canadian income taxation. It is noted that this is similar to the conclusion reached in respect of passive members of a general partnership: see e.g. Interpretation Bulletin IT-218R, paragraph 8; Randall v. The Queen, 85 DTC 5208 (FCTD); Rothenberg, 65 DTC 5001 (Ex.Ct.); and Carr, 65 DTC 5201 (Ex.Ct.), per Cattanach J. To be a partnership, there must be at least two persons carrying on a business in common with a view to profit.

It is noted that non-active members of a limited partnership (i.e., limited partners) are also imputed the same intention of the active members (i.e., general partners) and carry on the business of the partnership: see e.g. The Queen v. Robinson, 98 DTC 6068 (FCA); Grocott v. The Queen, 96 DTC 1025 (TCC), per Bowman J. (as he then was); and CRA documents 2006-0167421I7 and 2004-0105951E5. It is noted that following the Robinson decision, which held that limited partners carry on the business of a partnership, the Department of Finance introduced section 253.1 to deem a consequence contrary to Robinson. Section 253.1 generally provides that, for purposes of certain tax provisions, a trust or corporation that holds an interest as a limited partner in a limited partnership will not solely because of such holding be considered to carry on any business activity of the partnership.

Issue 2

Under the JV agreement, the JV members appoint Corporation A as the Operator of the JV's property, with the responsibilities of the Operator being defined in the same JV agreement. This fact alone, although it is evidence that an agency relationship could potentially have been created, is insufficient to determine whether in fact an agency exists between Corporation A and the JV members.

Whether or not an agency relationship exit between two persons in a particular case is a question of fact to be resolved by taking into consideration all documents and circumstances of the case under review.

The term "agency" is neither defined for income tax purposes, nor is it for GST purposes under the Excise Tax Act (Canada) (the "ETA"). The CRA has developed an interpretation of the meaning of "agency" for GST purposes: see Policy P-182R, revised July 2003. The Federal Court of Appeal even found the predecessor of this policy (P-182) to be a "useful tool" on the issue of agency for GST purposes: Glengarry Bingo Association v. Canada, [1999] G.S.T.C. 15 (FCA), leave to appeal to SCC refused: [2000] G.S.T.C. 9. In our view, P-182R is a useful tool with respect to determining the meaning of agency for income tax purposes. In Policy P-182R, the CRA indicates that the following three essential elements must be present in order for an agency relationship to exist:

1. Consent of both the principal and the agent;
2. Authority of the agent to affect the principal's legal position; and
3. The principal's control of the agent's actions.

P-182R lists the following indicators as evidence that the essential elements of an agency relationship are present:

a. Assumption of risk;

b. Accounting practice;

c. Remuneration;

d. Best efforts;

e. Alteration of property acquired;

f. Use of property or service;

g. Liability under contract/liability payment; and

h. Ownership of property.

Whether a person is acting as an agent of another person depends on a determination of fact and an application of principles of law, to ascertain whether the essential elements and indicators mentioned above are present in the relationship between the two persons. See also e.g. William J. Bies, "Agency in Canadian Income Tax Law," in Report of Proceedings of the Thirty-Fourth Tax Conference, 1982 Conference Report (Toronto: Canadian Tax Foundation, 1983), 927-39, at 927-29, referring to the often cited author on agency, even in Canada, G.H.L. Fridman, The Law of Agency, 4th ed. (London: Butterworths, 1976); and Bowstead on Agency, 14th ed. (London: Sweet & Maxwell, 1976).

An agency agreement between two persons, as other contracts, can be expressed (i.e., in writing or orally) or implied by course of conduct of the parties. As stated by G. H. L. Fridman, The Law of Agency, 7th ed. (Toronto: Butterworths, 1996), 59-61:

"The assent will be implied from the fact that he acted intentionally on another's behalf. But in general it will be the assent of the principal which is more likely to be implied... Such assent may be implied where circumstances clearly indicate that he has given authority to another to act on his behalf. This may be so even if the principal did not know the true state of affairs...Mere silence will be insufficient..."

In the scenario at hand, while the rights and obligations you described as being reflected in the JV agreement and the JV members' filing basis of the SR&ED claims suggest that the Operator is an agent of the other parties, we are unable to confirm this without a review of the entire JV agreement (as opposed to excerpts thereof), the conduct of the parties and other relevant circumstances of the case.

Issue 3

Subparagraph 37(1)(a)(i) requires that the SR&ED work be carried on in Canada, directly undertaken by or "on behalf of" the taxpayer. The French version of this provision uses "pour son compte" to translate "on behalf of". The expression "on behalf of" is not defined in the Act. The expression has at least two different dictionary meanings, the first being "in the interests of a person, group, or principle", and the second being "as a representative of": Compact Oxford English Dictionary (online). See also Merriam-Webster's Online Dictionary, 10th Edition (online); The American Heritage(r) Dictionary of the English Language (online); and Le Nouveau Petit-Robert (France, 1995).

Even though the words "on behalf of" typically represent an agency relationship, it has also on a few occasions been associated with a trust relationship: see e.g. Donovan W. M.Waters, Law of Trusts in Canada, 2nd ed. (Toronto: Carswell, 1984), at 42-46 (see more recently the 2005 edition). In our view, the expression "on behalf of" in subparagraph 37(1)(a)(i) generally concerns an agency type of relationship between the taxpayer and the SR&ED performer.

If Corporation A is an agent of the other JV members, the other JV members may claim their respective share of the SR&ED expenditures made by Corporation A.

If Corporation A is not an agent of the other JV members in respect of the SR&ED expenditures, the extent of each other JV member's ability to claim an amount as a deduction under subsection 37(1) and ITC in respect of any such amount would depend on the nature of Corporation A's relationship with each such JV member in respect of the SR&ED work. For instance, if a particular JV member was to make payments to Corporation A for SR&ED related to a business of the particular JV member in exchange of being entitled to exploit the result of the SR&ED performed by Corporation A, the payments by the particular JV member to Corporation A could be deductible under subparagraph 37(1)(a)(i.1) of the Act (see e.g. IT-151R5 (Consolidated), paragraphs 8 and 37; and SR&ED Application Policy 96-04).

Although the facts supplied in you referral are insufficient for us to conclude that Corporation A's SR&ED work can reasonably be considered its contribution to the JV, it is our view that generally speaking it is possible for a party's contribution to a joint venture to consist of that party's SR&ED work while the other parties' contributions consist of other assets, including money.

Issue 4

We agree with you that if the Operator is acting as agent for the other JV members, the JV members can claim their proportionate share of the SR&ED salary and wages based on their interest in the joint venture. If the Operator is not agent of the other JV members, only the Operator can claim the SR&ED salary and wages (i.e., the Operator would be able to claim all of the salaries and wages it incurred on SR&ED).

Issue 5

We agree with your view that it is not necessary that an amount of money be actually paid in order for the amount to qualify as an "expenditure" pursuant to subsection 37(1), provided that all other requirements are met. If the Operator is obligated to pay one of the JV members an amount from the JV business, but that JV member foregoes receipt of the amount so that the amount is used as that JV member's contribution to the JV, the foregone amount could be regarded as an expenditure of the JV member. The word "expenditure", which is not defined in the Act for the purposes of SR&ED, is not confined to money, and includes non-monetary consideration, such as the assumption of some liabilities.

In Alcatel Canada Inc. v. The Queen, the Tax Court held that a corporation had incurred an SR&ED "expenditure" when it issued shares to employees at less than the FMV pursuant to stock options: 2005 DTC 387 (TCC). The crux of the Tax Court's decision can be found at paragraph 31, which reads in part as follows:

"Expenditure is not confined to outlays of cash ... [a] very real expenditure is accomplished when shares having an established market value are sold for less than that value in the context of a scheme for the compensation of the employees who buy them. The benefit realized by the employees is real ... The expenditure consists of the consideration which the Appellant foregoes when it issues its shares for less than market value."

By concluding as it did, the Tax Court did not follow the majority of the Lords in Lowry v. Consolidated African Selection Trust, [1940] A.C. 648 (HL), and relied instead on the ordinary meaning of the word "expenditure" in Black's Law Dictionary, 8th ed., taking into account the object of the SR&ED provisions (which is to encourage SR&ED).

While the Crown did not appeal the Alcatel case, the Department of Finance countered the effect of the Alcatel decision by proposing new section 143.3 of the Act on November 17, 2005 (Bill C-33, then Bill C-10). For certain purposes, which include the computation of income, the new tax provision deems an amount of expenditure not to include any portion of an expenditure that arises because the taxpayer granted or issued an option to acquire its shares or those of non-arm's length persons. The Backgrounder released with News Release 2005-080 issued by the Department of Finance on November 17, 2005 in response to the Alcatel decision included the following comments with respect to the meaning of "expenditure" in the Act:

"The income tax system generally recognizes an expenditure to the extent that a taxpayer has provided consideration in the form of money or money's worth. Examples of non-monetary consideration include the provision of services, the provision of movable or immovable property and the assumption of a liability."

In our view, a JV member that forgoes a sum of money is equivalent to the JV member making a contribution payment of that same amount to the Operator.

Issue 6

Individual 2 would be considered to carry on the XXXXXXXXXX business by virtue of being a member of the JV. The expenditures in respect of SR&ED incurred by the Operator as agent of Individual 2 could be allocated to Individual 2 and claimed as such by Individual 2. Individual 2 would also generally be entitled to claim ITC earned in respect of such expenditures, subject to meeting the ITC requirements in section 127. The ITC restrictions imposed on members of a partnership, such as specified members under subsection 127(8) of the Act, would not be applicable to an inactive JV member since a JV is not a partnership.

We trust this information is helpful.

Yours truly,

S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch